"Economy" PDF

Every day, billions of people around the world make decisions. Many, but not all, of these interactions are related to some sort of exchange, normally with the use of a medium of exchange such as money, and sometimes to a direct exchange of services. Individuals purchase goods and services for final...

Every day, billions of people around the world make decisions. Many, but not all, of these interactions are related to some sort of exchange, normally with the use of a medium of exchange such as money, and sometimes to a direct exchange of services. Individuals purchase goods and services for final consumption and provide the inputs into production – land, labour and capital. We refer to these individuals collectively as ‘households’. The organizations which buy these factors and use them to produce goods and services are referred to collectively as ‘firms’. The amount of interaction between households and firms – the amount of buying and selling which takes place – represents the level of economic activity. The more buying and selling there are, the higher the level of economic activity. Households and firms engaging in production and exchange in a particular geographic region are together referred to as the economy. Our needs are the necessities of life which enable us to survive, food and water; and our wants are the things which we believe make for a more comfortable and enjoyable life. Our demand for these wants and needs is generally greater than our ability to satisfy them scarcity the limited nature of society’s resources A typical definition of economics is ‘the study of how society manages its scarce resources’ People Face Trade-offs A trade-off is the loss of the benefits from a decision to sacrifice one option, balanced against the benefits incurred from the choice made. When choosing between alternatives we must consider the benefits gained from choosing one course of action but recognize that we must forego the benefits that could arise from the alternatives. To get one thing we like, we usually must give up another thing that we might also like. efficiency deals with ways in which society gets the most it can from its scarce resources equity looks at the extent to which the benefits of outcomes are distributed fairly among society’s members opportunity cost: making decisions requires comparing the costs and benefits of alternative courses of action. The opportunity cost is the measure of the options sacrificed in making a decision. opportunity cost of good y= sacrifice of good x / gain in good y opportunity cost of good x= sacrifice og good y / gain in good x Marginal changes describe small incremental adjustments to an existing plan of action. Rational people make decisions evaluating the costs and benefits of marginal changes. rational people intentionally do the best they can to achieve their objectives. People Respond to incentives: incentives are something that induces a person to act, such as the prospect of a reward or punishment trade can make everyone better off rather than being self-sufficient, people can specialize in producing one good or service and exchange it for other goods. the same principles apply at the national and international level, countries can also benefit from one another markets can be a good way to organize economic activity ‘to organize economic activity’ means determining - what goods to produce - how much to produce them - how much of each to produce - who gets them a market economy allocates resources through the decentralized decisions of many households and firms as they interact in markets. Governments can sometimes improve market outcomes In some cases, Governments provide goods and services which might not be provided in sufficient quantities in a market system and set the legal and regulatory framework within which firms and households can operate. Government intervention in markets may aim to promote efficiency and equity Many public policies, such as income tax and the social security system, are designed to achieve a more equitable distribution of economic well-being. Economists use the term ‘market failure’ to refer to a situation in which the market on its own fails to produce an efficient allocation of resources. One possible cause of market failure is an externality, which is the uncompensated impact, both negative and positive, of one person’s actions on the well-being of a third party. For instance, the classic example of a negative externality is pollution. Another possible cause of market failure is market power, which refers to the ability of a single person or business to unduly influence market prices. In the presence of market failure, well-designed public policy can enhance economic efficiency. in the case of a market failure, public policies may promote efficiency. a country’s standard of living depends on its ability to produce good and services productivity: the amount of goods and services produced per unit of labour Prices Rise When The Government Prints Too Much Money inflation: increases in the general level of prices, is caused by a fast and excessive growth in the quantity of money. high inflation is a problem because it imposes various costs on society; keeping inflation at a low level is a goal of economic policymakers around the world economy’s goal is not to forecast events, but to explain how the world works. Economics studies decision-making and the effect of decision-making on a wide range of topic areas, but central to the study is human beings. Economics uses a lot of models. A model is a representation of reality which facilitates understanding of how something works. Economic models have two principal uses: one is for predicting or forecasting what might happen in the future as a consequence of a decision or policy, and the other is to simulate an event and provide a comparison with what would have happened if the decision, policy or change had not happened (the counterfactual). model contains a given number of variables: - definition of an exogenous variable; a variable whose value is determined outside the model  - definition of an endogenous variable; a variable whose value is determined within the model types of reasoning deductive reasoning: begins with things that we know to be true and then works through a process of using these facts to arrive to the question we are interested in, leading to draw an hypothesis that can be confirmed or rejected inductive reasoning: begins with observation from which patterns are identified. these patterns generate a hypothesis which may lead to a theory The principle of falsifiability is based on the assumption that we cannot know everything for sure and, as a result, researchers should clarify the conditions under which a theory can be proved false. the scientific method uses abstract models to help explain how a complex, real world operates. it is alway important to keep in mind that correlation does not imply causation. the fact that two events happens at the same time does not mean that A implies B reverse causality - B implies A omitted variables - C has an effect on both A and B selection bias - we only observe a subset of events spurious correlation - A and B are unrelated and just by coincidence they happened at the same time MARKETS AND COMPETITION buyers determine demand sellers determine supply a market is a group of buyers and sellers of a particular good or service One of the outcomes of the market model is that the resulting allocation of resources will be ‘efficient’. What this means is that the price buyers pay for goods in the market is a reflection of the value they get from acquiring that goods, and that the price producers receive is a reflection of the cost of production including an element of profit which is sufficient to keep them in that line of production a competitive market is a market in which there are many buyers and sellers so that each has a negligible impact on the market price Because products are homogenous, a seller has little reason to charge less than the going price, and if they charge more, buyers will make their purchases elsewhere. types of competition 1. perfect: products are the same, numerous buyers and sellers so that each has no influence over price 2. monopoly: one big seller who controls price on the market 3. monopolistic: many sellers who sell slightly differentiated products 4. oligopoly: few sellers not always in an aggressive competition Demand quantity demanded is the amount of a good that buyers are willing and able to purchase at different prices If the price of milk rose from €0.25 per litre to €0.35 per litre, less milk would be bought. If the price of milk fell to €0.20 per litre, more milk would be bought. the relationship between price and quantity demanded is referred to as the law of demand, the claim that, other thing being equal, the quantity demanded of a good falls when the price of the good rises the demand schedule is a table that shows the relationship between the price of a good and the quantity demanded the demand curve is a graph of the relationship between the price of a good and the quality demanded A change in the price of a good, which results in a change in quantity demanded, is represented graphically as a movement along the demand curve. an increase in quantity demanded could have two reasons: the income effect, assuming that incomes remain constant then and increase in the price of milk menas that consumers can now afford to buy less with their income the substitution effect, milk is higher in prices compared to other similar products so some consumers will choose an alternatives. a shift to the left or to the right is caused by any change that alters the quantity demanded at every price When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes (milk and fruit juice) When a fall in the price of one good raises the demand for another good, the two goods are called complements (milk and cereals) a change in income also affect demand. a lower income means less to spend in total. if the demand for a good falls when income falls or, rises as income rises, the good is called a normal good if the demand for a good rises when income falls, the good is called an inferior good tastes and number of buyers are also important in the quantity of demand Supply quantity supplied is the amount of a good that sellers are willing and able to sell at different prices the law of supply is the claim that, other things equal, the quantity supplied of a good rises when the price of the good rises. the supply schedule is a table that shows the relationship between the price of the good and the quantity supplied the supply curve is the graph of the relationship between the price of a good and the quantity supplied market supply refers to the sum of all individual supplies for all sellers of a particular good or services any change that raises quantity supplied at every price shifts the supply curve to the right and is called an increase in supply. Similarly, any change that reduces the quantity supplied at every price shifts the supply curve to the left and is called a decrease in supply. the factors affecting supply other than price are: 1. input prices - Dairy farmers, for example, will use fertilizer, feed, silage, farm buildings, veterinary services and the labour of workers. When the price of one or more of these inputs rises, producing milk is less profitable and firms supply less milk 2. technology which increases productivity allowing more to be produced using fewer factor inputs 3. natural/social factors 4. expectations of producers on future prices 5. number of sellers - If there are more sellers in the market, then it makes sense that the supply would increase. SUPPLY AND DEMAND TOGETHER Equilibrium is defined as a state of rest, a point where there is no force acting for change. the equilibrium price is what balances quantity supplied and quantity demanded. on the graph, is the price at which the supply and demand curves intersect the equilibrium quantity is the quantity supplied and the quantity demanded at the equilibrium price. on the graph it is the quantity at which the supply and demand curve intersect. The market will remain in equilibrium until something causes either a shift in the demand curve or a shift in the supply curve (or both). If one or both curves shift, at the existing equilibrium price, there will now be either a surplus or a shortage. a surplus, happens when the quantity supplied is greater than the quantity demanded at the going market price. so suppliers will lower the price to increase sales, thereby moving towards equilibrium a shortage, happens when the quantity demanded is greater than the quantity supplied at the going market price. so suppliers will raise the price due too many buyers chasing too few goods, moving towards equilibrium Individual buyers and sellers don’t consciously realize they are acting as forces for change in the market when they make their decisions, but the collective act of all the many buyers and sellers tends to push markets towards equilibrium. This phenomenon is referred to as the law of supply and demand: the price of any good adjusts to bring the quantity supplied and quantity demanded for that good into balance. Elasticity is a measure of how much buyers and sellers respond to changes in market conditions, and knowledge of this concept allows us to analyze supply and demand with greater precision. the price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price Demand for a good is said to be price elastic if the quantity demanded responds substantially to changes in price (1-). Demand is said to be price inelastic if the quantity demanded responds only slightly to changes in price(0-1). at points with low price and high quantity, the demand curve is inelastic at points with high price and low quantity the demand curve is elastic while the slope of a linear demand curve is constant, the elasticity is not the slope is the ratio between absolute variations of quantity and price -> it depends on the units of measure of price and quantity elasticity is the ratio between relative variations of quantity and price -> it does not depend on the units of measure of price and quantity total revenue is the amount paid by buyers and received by sellers of a good with a price inelastic demand curve, an increase in price leads to a decrease in quantity that is proportionately smaller = total revenue increases with a price elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger = total revenue decreases The cross-price elasticity of demand measures how the quantity demanded of one good changes as the price of another good changes. It is calculated as the percentage change in quantity demanded of good 1 divided by the percentage change in the price of good 2. if EqA,pB>0, A and B are substitutes if EqA,pB consumers usually prefer more of something to less of it, and higher indifference curves represents larger quantities of goods 2. indifference curves are downward sloping -> a consumer is willing to give up one good only if he gets more of the other good 3. indifference curves do not cross 4. indifference curves are bowed inward -> decreasing MRS total utility is the satisfaction that consumers gain from consuming a product marginal utility of consumption is the increase in utility that the consumer gets from an additional unit of that good diminishing marginal utility refers to the tendency for the additional satisfaction from consuming extra units of a good to fall the marginal rate of substitution equals the marginal utility of one good divided by the marginal utility of the other good MRSx,y in a given point is equal to the slope of the indifference curve at that point: 𝚫y/𝚫x let U (x,y) represents a generic utility function of a consumer. we denote by MUx the marginal utility of consumption with respect to good x and MUy the marginal utility of consumption with respect to good y if MUx𝚫x+MUy𝚫y=𝚫U=0 -𝚫y/𝚫x=MUx/MUy |MRSx,y|=MUx/MUy for higher quantity consumed of x, the marginal utility of one more unit of x is lower, if the MU is lower, the consumer will be less willing to give up units of y in order to increase x by one unit. people are more willing to trade away goods that they have in abundance and less willing to trade away goods of which they have little 1- perfect substitutes two good with straight-line indifference curves are perfect substitutes, the marginal rate of substation is a fixed number 2- perfect complements two goods with right angle indifference curves are perfect complements, two goods must always be consumed in the same proportion consumers want to get the combination of goods on the highest possible indifference curve, also taking into account the constraint of income consumer optimum occurs at the point where the highest indifference curve and the budget constraint are tangent slope of indifference curve in a given point =MRSx,y slope of budget constraint =-Px/Py the consumer chooses consumption of the two goods so that the absolute value of the marginal rate of substitution equals the ratio between the price of the two goods an increase of income shifts the budget constraint outward normal vs inferior goods: if a consumer buys more of a good when his income rises, the good is called normal; if a consumer buys less of a good when his income rises, the good is called inferior good a fall in the price of any good rotates the budget constraint outward and changes the slope of the budget constraint a price change has two effects on consumption 1. an income effect, is the change in consumption due to a change in price affecting the “purchasing-power” of the consumer with respect to all goods” -> when a price change moves the consumer to a higher or lower indifference curve 2. a substitution effect, is the change in consumption due to the change in the relative prices of the goods -> when a price change moves the consumer along an indifference curve to a point with a different marginal rate of substitution Initial bundle (A): initial prices Final bundle (C): new prices. The consumer moves from A to C due to the income and substitution effects a consumers demand curve can be seen as a summary of the optimal decisions that arises from his budget constraint and indifference curves the price consumption curve is a line showing the consumer optimum for two goods as the price of only one of the goods changes demand curve can sometimes slope upwards this happens when a consumer buys more of a good when its price rises giffen goods -> a term used by economists to describe a good that violates the law of demand. the income effect dominates the substitution effect the income expansion path relates variation in income with variation in optimal consumption choice engel curve a line showing the relationship between demand and levels of income the case when a person’s demand is affected by the number of people who have purchased the good, is called a network externality a positive network externality exists if the quantity of a good demanded by a consumer increases in response to an increase by other consumers negative network externality are just the opposite a product exhibits positive network externalities if the individual utility from consuming a good is increasing in the number of other users consuming that good (bandawagon effect) if the network externality is negative, a snob effect exists. refers to the desire to own exclusive or unique goods THE COSTS OF PRODUCTION a firms’s cost are a key determinant of its production and pricing decisions a firm’s cost of production includes all the opportunity cost of making its output of goods and services. The cost of ingredients and labour require that the firm pay out some money, and such costs are referred to as explicit costs / implicit costs are input costs that do not require an outlay of money by the firm the production function shows the relationship between quantity of inputs used to make a good and the quantity of output of that good the marginal product of any input in the production process is the increase in the quantity of output that arises from an additional unit of that factor input = change in total product / change in quantity of the factor = 𝚫Q/𝚫L diminishing marginal product is the property whereby the marginal product of an input declines as the quantity of the input increases. the slope of the production function measures the marginal product of an input, when the marginal product declines, the production function becomes flatter the relationship between the quantity a firm can produce and its costs is illustrated by the total cost curve. cost of production may be divided into fixed costs and variable costs: fixed costs do not vary by the quantity of output produced variable costs are those costs that are vary on the quantity of output produced for many firms, the division of total costs depends on the interval of time being considered, in the short run, some costs are fixed; in the long run, fixed costs become variable costs total costs total fixed costs TFC total variable costs TVC total costs TC TC=TFC+TVC average costs, can be determined by dividing the firm's costs by the quantity of output it produces (the cost of each typical unit of product) average fixed costs AFC -> FC/Q average variable costs AVC -> VC/Q average total costs ATC ATC=AFC+AVC the marginal costs measures the increase in total cost that arises from an extra unit of production, = change in total cost/ change in quantity = 𝚫TC / 𝚫Q